Beyond Borders, Within Societies: Inequality and the Global Transmission of US Monetary Policy

Heterogeneous effects of US monetary policy on foreign economies' GDP 

Non-Technical Summary

Monetary policy decisions taken in the United States have long been known to affect economic conditions far beyond its borders. When the US central bank raises interest rates, borrowing costs tend to increase globally, financial conditions tighten, and economic activity often slows in other countries. While these international spillovers are well documented, less is known about why their strength varies across countries and over time. This paper shows that one important factor shaping these differences is income inequality within countries. In particular, it highlights that the distribution of income across households plays a key role in determining how strongly foreign economies respond to changes in US monetary policy.

Using data for a large sample of advanced and emerging economies over several decades, the paper finds that higher income inequality tends to amplify the negative impact of a US monetary policy tightening on economic activity. As shown in the Figure below, in countries where income is more unevenly distributed, output declines more sharply following an increase in US interest rates. Quantitatively, the contraction in output can be up to one and a half times larger in high-inequality environments than in more equal ones. However, this relationship is not uniform across countries. A key finding of the paper is that the role of inequality differs markedly between advanced economies and emerging market economies. In advanced economies, higher inequality consistently strengthens the contractionary effects of US monetary policy. By contrast, in emerging markets, higher inequality appears to mitigate these negative spillovers, resulting in smaller declines in economic activity. 

To understand these contrasting patterns, the paper develops a multi-country model that distinguishes between different types of households. Some households have access to financial markets and can adjust their savings and investment decisions in response to changes in global interest rates, while others are financially constrained and rely on their disposable income. When US interest rates rise, financially unconstrained households shift their investments towards US assets, which now offer higher returns. This reallocation can trigger capital outflows from domestic economies, tighten financial conditions, and deepen the downturn. The strength of this mechanism depends on both the level of inequality and households’ ability to participate in international financial markets.

In advanced economies, where access to global financial markets is relatively widespread, higher inequality implies a larger share of households actively reallocating their portfolios in response to US monetary policy. This amplifies capital outflows and strengthens the negative impact on domestic economic activity. In emerging market economies, however, access to international financial markets is often more limited. Even when inequality is high, many households are unable to shift their investments abroad and instead direct them towards domestic assets and consumption. As a result, the channel through which capital flows out of the domestic economy is weaker. In this context, higher inequality can dampen the transmission of US monetary policy, as the mechanisms that would otherwise amplify the shock are less operative.

These findings suggest that both domestic income distribution and the structure of financial markets are crucial for understanding how global shocks propagate across countries. They also highlight that policies aimed at improving financial inclusion and market access can influence not only domestic economic outcomes but also a country’s exposure to international financial conditions. Overall, the paper contributes to a better understanding of the interaction between global financial forces and domestic economic structures. It shows that inequality is not only a social concern but also a macroeconomic factor shaping how economies respond to international developments. By combining evidence from a large set of countries with a theoretical framework, the analysis provides new insights into the global transmission of monetary policy in an increasingly interconnected world.

Keywords: US Monetary Policy, Spillovers, Income Inequality, Local Projections, State-Dependence

Codes JEL : D31, E21, E52, E58, F42